In an environment of rising inflation and interest rates, commercial real estate lenders and investors are increasingly examining the resilience of income streams as they look to understand any potential economic exposure behind their returns and the risk of a tenant default on rental payments.
The analysis comes as a new report from MSCI published this week suggests going beyond aggregate-portfolio analysis may help investors identify concentrations of risk tied to geographies, tenant industries and individual companies across their holding structures.
“Often, tenant companies have complex holding-company structures that make tenant concentration risk difficult to estimate, especially for cross-border portfolios,” the report stated, noting that it is critically relevant for real estate investors to track corporate structures to determine if the parent company guarantees rental payments for the child company because this reduces default risk.
“By looking at aggregated income of parent companies, in conjunction with the weighted average default-risk scores, it may be possible to spot specific tenants that contributed disproportionately to the risk of the overall portfolio,” the report continued.
The MSCI report, published in conjunction with MSCI’s Pan-European Quarterly Property Fund Index, comes as inflation and higher interest rates continue to rattle the global financial markets. The index demonstrates income return has constituted the bulk of total return over time, that property type can hide a range of economic exposure to tenant industries and that income risk varies across and within sectors and tenant industries.
Exposure to property types look different when measured by remaining income, with the MSCI index finding that exposure to industrial and retail was higher when measured in this way compared with measuring by capital value.
The opposite has often been true for residential and office, with consistently higher exposures to remaining income than capital value. The main drivers of these trends were yield and lease length, which both determine the relationship of remaining income to capital value, and varied themselves by property type and country.
But income risk varies across and within tenant industries, too, and the report found that classifying portfolio tenants by industry can also provide an alternative lens for analysis. One of the report’s findings was that 75.3% of remaining income was contracted to tenants in just three segments: consumer staples, consumer discretionary and industrials.
The data shows a significant proportion of the income from a retail asset may be derived from non-retail tenants or from retail subsegments, which may be more resilient to online retailing and inflation than consumer discretionary.